Koreans cast wary eyes on yen movement

By Kim Tong-hyung

Considering the scale of the human catastrophe, any attempt at assessing the economic cost of the Japanese earthquake would seem perverse. But Korean policymakers will have to do so anyway.

It was already starting out as a dismal year for the world economy when the disaster struck and began slashing stock markets. And the early efforts to put a price on the damages may prove futile as the natural tragedy threatens to convert into a nuclear one.

Witnessing the destruction in northeastern Japan, Korean government officials have been announcing a slew of aid and rescue offers and speechifying about how Korea must prove itself as a “true neighbor” to the island nation in times of despair. But their language becomes less assertive when quizzed about the consequences the Japanese earthquake could have on the Korean economy.

In a meeting between economy-related ministries, Wednesday, Strategy and Finance Minister Yoon Jeung-hyun failed to offer more than banalities.

“As the writers of government policies, we must assess how the Japanese earthquake impacts us and prepare our responses. But now is also the time to be reminded of the old saying that ‘a friend in need is a friend indeed,”’ Yoon said.

“There are growing concerns over continuing problems from the Japanese nuclear reactors and these are being shown in financial markets here and abroad, manifested most clearly in the dramatic slide of the Nikkei index. Each ministry should make its efforts around the central response team and monitor the situation closely. It’s important to provide the public with accurate facts and prevent fear from spreading more than it has to.”

Even before Japan was hit by the current earthquake, tsunami and nuclear crisis, the global economy had been laboring under high fuel prices, driven by the turmoil in the Middle East and North Africa, financial instability in Europe and a slowing Chinese economy.

And for the past few months Korean policymakers had been losing their fight against inflation, coupled with subduing economic activity. Now, some analysts say the immediate impact of the Japanese crisis, combined with the country’s efforts to recover from it, will further intensify the price pressure felt by Koreans.

In the wake of the recent earthquake, the Bank of Japan moved quickly to restore confidence in markets by flooding them with liquidity. The 18 trillion yen (about $220 billion) it signed off in the quantitative easing programs represents a record spending by the central bank.

The debate among market watchers is chiefly about what happens to the value of the yen now. The Japanese currency has been appreciating sharply against the U.S. dollar since the massive earthquake, climbing to as high as 76.25 on Thursday (KST), the highest level since the end of World War II.

Some observers say the increased demand for yen assures that its value will continue to climb, especially should Japanese investors begin to repatriate their overseas assets en masse to pay for earthquake damages.

But others argue that the yen’s post-quake rally will fade due to Japan’s loosened monetary conditions, as the intentions in Tokyo are clearly to ease the upward pressure on the local currency. And the continuing troubles at Japan’s nuclear power facilities could make money managers wary of taking on Japanese assets and eventually erode the yen’s traditional appeal as a safe asset.

A stronger yen could benefit Korean companies by upping the competitiveness of their exports, particularly in technology products and automobiles. However, this would also intensify the inflationary pressure in global markets and rattle what is already a fragile recovery.

In comparison, a weaker yen could help prices on global commodity markets regain their sense of gravity. But this might add to the frustrations of Korean policymakers, who in their fight against inflation, showed more willingness to permit the won to strengthen to a degree than to dramatically rewrite interest rates, according to some observers.

“Japanese policymakers are determined to induce a weaker yen, as they will not want to repeat the experience of the Kobe earthquake when the yen surged in the aftermath and had a tightening effect on the country’s export-driven economy. Japan’s economic and fiscal conditions are significantly different from 1995 and there are no fundamental factors that predict that the yen will strengthen,” said Park Sang-hyun, an economist from Hi Investment and Securities, who is footed firmly in the weaker yen camp.

“It’s hard to predict how a weaker yen would affect the Korean efforts to combat inflation. The currency control options based on the won-dollar exchange rate will obviously be limited, but the weaker end could convert into a stronger U.S. dollar, which would take the air out of commodity prices.”

Kim Jong-soo, an economist from NH Investment and Securities, is among those who anticipate the yen to surge driven by the increase in funds repatriated by Japanese companies in expectation of big rebuilding activity. It’s difficult to imagine the yen weakening when the dollar appears to have no shot at strengthening, unless the U.S. Federal Reserve unexpectedly decides to bump up interest rates, he said.

“The demand for yen now is obvious. The value of dollar will likely slide and ease the global inflationary pressure,” he said.

But lost in the arguments over the future movement of the Japanese currency is the possibility that the yen might not budge significantly after all, says Oh Suk-tae, chief economist at SC First Bank.

Whatever happens to the yen will have a limited impact on the effectiveness of Korean monetary policies, Oh says, as the link between the won-dollar and yen-dollar exchange rates hasn’t been consistent.

“I personally think that all the talk about the yen weakening or strengthening is fueled by wishful thinking. It’s hard to say that the yen has showed signs of moving significantly in either direction,” Oh said.

“The changes in the value of the yen post-quake will be marginal. For the mid-to-long term, we predict the yen to weaken and eventually settle around 90 yen to the dollar, but this doesn’t have anything to do with the earthquake.”

The Lee Myung-bak government, which had insisted on putting growth before price stability, is struggling to deal with higher prices coupled with subdued economic activity and economists are beginning to wonder whether stagflation is at the doorstep.

Consumer prices rose 4.5 percent in February from a year ago, significantly faster than the government’s 3 percent target, while producer prices jumped 6.6 percent, the fastest pace in 27 months.